Why we are backing EUR/USD parity very soon

EUR/USD Facing A March Below Parity In 1-3 Months –


Why is this important to traders?

According to the Bank for International Settlement (BIS), which compiles statistics in cooperation with world central banks to inform analysis of global liquidity, among other things, the US Dollar and the Euro are the two most traded currencies in the world. And EUR/USD is the most traded pair.


EUR/USD TRADING BASICS:

The US Dollar (USD) is the world’s dominant currency and the Euro (EUR) is the second most-traded.

As a result, business in EUR/USD accounts for almost a quarter of trading in global foreign exchange markets according to the BIS triennial report, which covers institutional trading.

EUR/USD is a highly liquid pair.

The EUR/USD could face new headwinds after Rabobank & other banks posted a negative outlook for the pair, predicting a fall below parity in the weeks ahead.

  • Solid US job creation in July temporarily spooked the recession ghost.

  • European data signals a contraction spiral just beginning in the Union.


Additional Euro-negative fundamentals are coming.


This week’s fundamental triggers for the pair come mainly from the US inflation data. The headline and core consumer price indices are due on Wednesday, while the producer price index (m/m) is due on Thursday. The consensus is for the headline and core CPI to have dropped from 1.3% to 0.2% and from 0.7% to 0.5%, respectively.


Before the weekend, Moody's cut the outlook for Italy's rating to negative from stable. It cited the accumulation of risks stemming from Russia's invasion of Ukraine and the political uncertainty following the collapse of the Draghi government. Of the three large rating agencies, Moody's is the toughest on Italy. It assigns a Baa3 rating to it, which is one notch above junk and one notch below S&P and Fitch. Late last month, S&P revised its rating outlook for Italy to stable from positive. Fitch has had a stable outlook. Last week, Italy's premium over Germany on 10-year rates fell 14 bp, including nearly half (six basis points) ahead of the weekend to near 2.06%, a three-week low. It has given the pre-weekend gains back and is near 2.13%. At the two-year tenor, Italy's premium fell 30 bp to 0.81%, the least since mid-July and has also recovered the pre-weekend decline and is near 0.89%.


With a national election next month Italy's political drama is centre stage. Meloni, the head of the Brothers of Italy, who could become the next prime minister (and first woman) is not from the part of the Italian right that is anti-EU, anti-NATO. To the contrary, she committed to the reforms that will unlock more of the EU's Next Generation funds, for which Italy could be the largest beneficiary. The centre-left looks like its flailing. A coalition announced on Saturday was abandoned on Sunday. Without a credible coalition the polls warn that the centre-right can win as much as three-quarters of both chambers of parliament. Meanwhile, the flexibility the ECB has secured in reinvesting the maturing proceeds from the Pandemic Emergency Purchase Program already appears to have been utilized to support the peripheral bond markets.


In addition, to the disruptions spurred by Russian's invasion of Ukraine, post-Covid supply chain disruptions, and the tightening of monetary policy, the extreme weather in Europe is also exacerbating economic tensions. It is the driest in Britain in 90-years according to some estimates. The Rhine River is becoming too shallow for transport of heavy materials, and French nuclear plants have been given a temporary waiver to dump hot water in the rivers that are meant to help cool the plants.


Data imbalances


Macroeconomic data released these past few days showed that the US is in better shape than the EU. German and EU Retail Sales fell into negative territory in June, while manufacturing output in the region stood in contraction territory in July. Services activity in Germany is also contracting, although for the whole EU is holding in expansionary territory. Finally, Industrial Production and Factory Orders in the European most developed economy contracted on an annual basis in July.


US business activity, on the other hand, remained in expansion territory in July, according to the official ISM PMIs. Good news is that the prices paid contracted sharply, bad news is that new orders did the same. Also, Factory Orders rose by more than anticipated in June, up 2% MoM, while the Goods and Services Trade Balance in the same month posted a narrower-than-expected deficit of $79.6 billion.


Inflation will take centre stage next week as Germany will release the final estimates of its July Consumer Price Index, expected to confirm an increase of 7.5% YoY. The US will also publish July figures, with the CPI inflation foreseen easing from 9.1% to 8.7% YoY, but the annual core reading is expected to increase from 5.9% to 6.1% YoY.


The macroeconomic calendar will also include the July US Producer Price Index and the preliminary estimate of the August Michigan Consumer Sentiment Index. Finally, the Union will unveil August Sentix Investor Confidence and July Industrial Production.


Energy & the Eurozone


“Without any important Eurozone economic data EUR/USD is likely to be driven by trends in the USD,” writes Kristina Clifton, a senior economist and currency strategist at Commonwealth Bank of Australia, in a Monday research briefing.


“We expect EUR/USD to trade below parity, more than just briefly, sooner rather than later. EUR is also likely to remain heavy against other major currencies as issues with energy supply and prices remain front of mind,” Clifton added.


Some Fed policymakers reiterated last week that U.S. interest rates are likely to top 3% or more this year and also appeared to repeatedly warn financial markets away from their recent assumption that borrowing costs could then be cut quickly and as soon as the second quarter of 2023.


But the danger is now that U.S. inflation data out on Wednesday would force markets to abandon any residual bets on 2023 rate cuts and to instead price-in more aggressive action from the Fed, which would threaten to heap further pressure onto the Euro in the second half of the week.


“We expect both headline and core inflation to remain high in the month. Continued hawkish messages from the Fed and a strong CPI result can see financial markets start to shift pricing back towards a higher peak in the Funds rate,” CBA’s Clifton says.


Watch this space.